|This article does not cite any references or sources. (December 2009)|
A supply shock is an event that suddenly changes the price of a commodity or service. It may be caused by a sudden increase or decrease in the supply of a particular good. This sudden change affects the equilibrium price.
A negative supply shock (sudden supply decrease) will raise prices and shift the aggregate supply curve to the left. A negative supply shock can cause stagflation due to a combination of raising prices and falling output.
A positive supply shock (an increase in supply) will lower the price of said good and shift the aggregate supply curve to the right. A positive supply shock could be an advance in technology (a technology shock) which makes production more efficient, thus increasing output.
The diagram to the right demonstrates a negative supply shock; The initial position is at point A, producing Y1 quantity, at P1 prices. Then there is a supply shock, this has an adverse effect on aggregate supply, the supply curve shifts left (from AS1 to AS2), while the demand curve stays in the same position. The intersection of the supply and demand curves has now moved and the equilibrium is now point B, quantity has been reduced to Y2, while prices have been increased to P2.
The slope of the demand curve, known as the price elasticity of demand, determines how the price responds to the shock. Since the short-term demand is likely to have lower elasticity (higher slope) than the long-term demand, over time the demand curve will shift in response to the price shock, resulting in an adaptation to the change in supply.
Czech, Brian, Supply Shock: Economic Growth at the Crossroads and the Steady State Solution. (Gabriola Island, Canada, 2013)